Derivatives Pioneer Blythe Masters Tackles Digital Currency

Blythe Masters has seen the future before, and Wall Street
followed. Will it happen again?

If the development of virtual currencies is the story of a
long cultural struggle between the idealistic hackers who
founded them and the incumbent powers of the financial
industry, this year has already seen established money strike
two major blows. In March, San Francisco Bitcoin firm 21
emerged from stealth mode to announce a $116 million round of
venture funding, the largest ever by a company in the digital
currency sector. But it was the announcement of Wall Street
pioneer Masters, 46, as CEO of Digital Asset
Holdings  a New York start-up with fewer than 20
employees that has yet to launch a single product  around
the same time that really caught the attention of the
investment world.

Digital currency businesses are now a serious destination
for venture capital: $350 million was poured into the sector in
2014, and $230 million has already been invested this year,
according to London-based data firm CoinDesk.

But while VCs have been busy pumping cash into
Bitcoin, the big beasts of Wall Street have mostly stayed
on the sidelines. The appointment of Masters, who spent 27
highly successful years at JPMorgan Chase & Co. before
leaving the firm last year after overseeing the sale of its
commodities unit, changes that.

Digital Asset was launched late last year by finance
veterans Sunil Hirani and Don Wilson; funding for the venture
has come from the founders own pockets as well as friends
and family, says Masters. Its perhaps no accident that in
the weeks since her new job was made public, several big banks
have announced digital currency initiatives. In early April,
for instance, UBS said it was starting a new innovation lab to
explore financial applications of the
blockchain, the infrastructure on which Bitcoin is
built.

Bitcoin, launched in 2009, is the oldest and best known
piece of a thriving global network of digital currencies.
Digital Asset  which, unlike other new entrants in the
sector, has no designs on being a trading business or an
exchange  will focus not on these currencies as
currencies. Instead, Masters says the company will exploit the
distributed databases that are their structural core to build a
software service that will effect quicker, cheaper, more
secure settlement of trading in mainstream and digital
assets.

The youngest woman to achieve the title of managing director
in JPMorgans history, Masters helped create the
derivatives market, which came to dominate institutional
trading through the 1990s and 2000s. Her status as the
inventor of credit default swaps, the trigger
instrument for the collapse of American International Group,
has made her a sometimes controversial figure. But Masters, who
was born and raised in the U.K. and studied economics at
Cambridge University, says her experience of the financial
crisis and the ensuing
debate over reform has convinced her of the need for
something to replace the old-fashioned
infrastructure that Wall Street uses to settle
trades.

The wave of change that the Dodd-Frank Wall Street Reform
and Consumer Protection Act and Basel III rules have brought to
global banking may have helped reduce counterparty and systemic
risk in the clearing and execution of trading activity, but
settling a trade in the U.S. still takes anywhere from two days
(for Treasuries) to 27 (for syndicated corporate loans).

Masters is betting that the cost and risk to financial
institutions that comes from having to keep traded assets on
their balance sheets as they wait for settlement will entice
them to consider a cheaper, faster, more secure alternative
 especially when it comes to the slowest-settling assets
such as private stocks, emerging-markets currencies and
syndicated loans. The blockchain, a distributed public ledger
that allows for the transfer of title to digital assets in a
decentralized, real-time fashion, could be the answer, though
Masters concedes that it will take a lot to convince
conservative, risk-averse financial firms to abandon familiar
practices for untested new technology.

Theres been this aura that Bitcoin is bad,
she says. Its the cowboys. Its not
real. Its not responsible.
Masters spoke to
Senior Writer Aaron Timms about her plans to change that,
and how the shifting political and cultural landscape for the
alternative currency sector is opening up opportunities for
businesses such as Digital Asset.

Institutional Investor: Youve had a long and
enormously successful career at one of the worlds biggest
banks. Whats the appeal of joining a place like Digital
Asset?

Blythe Masters: It might be a small
company, but its a really big opportunity. And because of
my extensive background in financial services, I think Im
in a position to understand the opportunity for what it is.
Im not a technologist  fortunately this
companys got plenty of those. But what I bring to the
table is essentially the ability to bridge the gap between the
digital and programming world and the world of existing
financial infrastructure and all its players. I think the
technology itself is transformational, and the scale of the
markets to which it can and should be applied is enormous. But
the number of people who populate that middle ground, who are
able to translate or bridge the gap, is relatively small.

Everyone talks about the enormous potential of
alternative currencies and their underlying technology. But the
whole world of Bitcoin and other currencies was set up to
resist centralization and intermediation. It didnt want
to be part of the organized financial industry; it was openly
scornful of it, and theres still a strong libertarian,
antibank strain to much of the sector today. Do you think these
worlds want to be bridged?

I would say that your general characterization of some in
the space is correct. But if you had a really good idea about
how to build a better tire for an automobile, you would
probably be really interested in talking to the auto companies
because they are the people that ultimately are going to make
use of your technology. You could think that maybe, because of
the power of your tire, there might emerge a whole new brand of
auto companies that supplant the General Motors of this world
because the incumbents never really got the whole concept of
what a good tire should be all about. But Im not sure
that would be a good move.

What are you hoping to achieve with Digital
Asset?

Were a wholesale-oriented technology company that is
seeking to develop software and services for the application of
distributed digital databases, including but not limited to the
blockchain, for effecting quicker, more secure settlement of
mainstream financial assets as well as digital assets. The
actual front end of transactions happens at almost warp speed,
and yet the process of completing transactions, according to
their contractual terms and transferring title to the
underlying, is slow. Slow means a higher cost associated with
capital requirements, higher risk because of the possibility of
something breaking in the period between transaction and
completion of the transaction, which, obviously, became front
of mind during the financial crisis of 2008.

The other problem with settlement today is that its
not particularly secure: Theres a lot of electronic
information about assets out there, but not all of it is
encrypted. And lots of it is stored in centralized places that
are very vulnerable to cyberattack or some other operational
failure, which is the kind of thing that can happen when you
have a centralized, single point of entry to a system.
Were seeking to provide a service that minimizes the
amount of risk our users take on. Not surprisingly, the lower
the risk you create to the entity in question, the lower the
need for
regulation in that context.

So youre against regulation?

No! This is completely different to the notion that
regulation is inherently a bad thing, which youve
correctly identified as a theme in this community, or that the
world would be better off without financial intermediaries,
without central banks, without governing powers. Thats
not a world that we promote or believe is realistic.

Were actually in favor of a lot of the aspects of the
existing world, including trusted parties, government
oversight, the transparency needed to facilitate that. Audit
trails, limits and command-and-control infrastructure, KYC
[know-your-customer protocols], AML [anti-money-laundering
rules], legal foundations to detect and deter illegal financial
activity  all of those things are positive aspects of
todays world that should be preserved. But theyre
slowed down because the existing infrastructure doesnt
have all the benefits of the best of digital technology such as
the blockchain. Our idea is to blend the best bits of both.

Digital Asset will become a financial intermediary
in some way, will it not? Dont you lose the fundamental
character of the blockchain  its decentralized,
distributed, trustless nature, which is key to the whole power
of the network  the moment you start slapping services
and so on on top?

You dont. Were preserving and not at all
interfering with the concept of direct peer-to-peer,
entity-to-entity transactions. Our services will operate on top
of the blockchain or other pieces of similar infrastructure,
but the underlying transactions will stay fully distributed in
an encrypted environment. What were not reintroducing
here is a notion of some entity that you have to trust
intermediating on your behalf. That is the reason why you
dont lose the core capability of the technology. But
well place these services in line with existing
regulations and transparency.

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